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Thursday, October 8, 2015

Ben Bernanke: courage and confusion

by Michael Roberts

Former Federal Reserve chief Ben Bernanke, who presided over the
global financial crash and the ensuing Great Recession, has a new book
out, now that he has returned to academia. The book, with a title that
has a certain defensive hubris (The Courage to Act: A Memoir of a Crisis and its Aftermath) focuses mostly on the events of the financial crisis, but it also includes personal anecdotes from before Bernanke’s time at the Fed, dating as far back as his childhood in a small town in South Carolina.

In the book, Bernanke defends the actions of the Fed under his helm
in the wake of the financial crisis; in particular the decision to bail
out most of the leading investment banks with huge credits and taxpayer
cash. He argues that “there was a reasonably good chance that,
barring stabilization of the financial system that we could have gone
into a 1930s-style depression.” Interestingly, he claims that he
would have liked to have saved the investment bank, Lehman Brothers, in
September 2008 as well but was forced to allow it to fail because “we were out of bullets at that point.” Out of money?

But what caused this financial collapse in the first place? He now
argues that it was greedy and even criminal acts by those who ran the
investment banks and mortgage lenders. He told USA Today magazine that
more of the bankers and corporate executives who helped cause the
financial crisis should be in jail. He says the Department of Justice
focused too much, in the wake of the meltdown, on sanctioning financial
firms and getting large fines. He said there wasn’t enough effort put
into punishing individuals. “It would have been my preference to
have more investigation of individual action, since obviously everything
what went wrong or was illegal was done by some individual, not by an
abstract firm…“What I was talking about is that we do know
that…many big banks, the Department of Justice assessed billions and
billions of dollars against the firms for bad behavior of various
kinds,” he said. “If there are bad actors, you should go after them individually”,
he said. However, Bernanke did not speak out at the time because the
Fed didn’t have the power to jail anyone. The failure to act on
criminality lay with the Justice Department.

But he defends the bailout. “We could’ve gone into a 1930s-style depression,”
says the former Fed chairman. This is disingenuous to say the least.
What was the Fed doing while those at the investment banking credit boom
party were dancing along with ever mounting sub-prime mortgages and
derivatives – the financial weapons of mass destruction, as Warren
Buffet called them? Nothing.
Although an academic expert on the nature and causes of the Great
Depression of the 1930s, Bernanke (like nearly all mainstream
economists) failed to see the oncoming financial collapse. In his statement to Congress in May 2007, when the sub-prime mortgage collapse was just getting under way, Bernanke said “at
this juncture . . . the impact on the broader economy and financial
markets of the problems in the subprime markets seems likely to be
contained. Importantly, we see no serious broader spillover to banks or
thrift institutions from the problems in the subprime market”.He
went to estimate that the likely losses to the financial sector of the
mortgage crisis in the US would be “between $50 billion and $100
billion”. It turned out to be $1.5trn in the US and another $1.5trn
globally.

After the crash was over in September 2010, Bernanke, pronounced on
the causes of the financial collapse of 2008 and the subsequent Great
Recession in testimony to the US Financial Inquiry Commission.
He concluded is that it was excessive reliance on short-term funding of
key institutions causing instability in the system. This theory,
dating from Walter Bagehot in the 19th century, was that
banks should not borrow short-term money, but instead get long-term
capital. But if banks just relied on customer savings deposits or on
long-term bonds and equity investors for their funding, would that have
stopped the financial crisis? I don’t think so.

That’s because the cause of financial crisis lay in increasing
difficulty for capitalist companies to sustain their profitability in
productive investment in the lead-up to the crash. As a result, the
financial sector switched more and more to speculative investment in
real estate and monetary instruments (of ‘mass destruction’). But to
fund the increasing demand to speculate, they had to borrow more money.
‘Leverage’ or debt rose sharply. When the value of all these
unproductive assets (mortgages, credit derivatives etc) started to fall,
the financial crisis ensued. It was nothing particularly to do with
‘short-term funding’. That only came into play when banks rushed to get
more money to service their debts and found that they would not lend to
each other. As Marx long ago explained, in a crisis, suddenly a
surfeit of money becomes a famine and then there is a desperate rush to
hold onto it.

Again back in January 2014, when he finished his term of office, Bernanke signed off with speech at the annual meeting of the American Economics Association. For Bernanke, the global financial collapse “bore
a strong family resemblance to a classic financial panic, except that
it took place in the complex environment of the 21st century global
financial system.” So, for Bernanke, the crisis was purely
financial in origin. It had nothing to do with any flaws or
contradictions in the capitalist mode of production, but was due to a
relaxation on mortgage lending which led to a housing bubble that burst;
too much leverage (borrowing) for speculation; and the use of ‘exotic’
financial instruments that did not ‘diversify’ the risks of lending too
much, but instead redistributed it globally. This explanation of the
widespread and deep nature of the financial panic’ is clearly correct in
describing the triggers of the global financial crash. But it does not explain why it happened and why then.

Bernanke, in his academic mode, had established his reputation as the
leading economic historian of the Great Depression of the 1930s. In his
view, following his hero, Milton Friedman, the Great Depression was the result of wrong policies adopted by the Federal Reserve.
First, the Fed in the 1920s allowed excessive lending and kept interest
rates too low. Then in the 1930s it applied too tight a monetary
policy and raised interest rates. The result was a stock market bubble
and then an extended depression in growth and employment.

There is some truth in this analysis. As G Carchedi explains in an unpublished paper, “the
monetary authorities often intervene by contracting the quantity of
money and/or raising the federal rate. These restrictive policies worsen
the financial situation of economically weak firms. They cannot service
their debt. Their bankruptcy and, thus the crisis, ensues”.

In this crisis, as he says in his AEA address, Bernanke
‘courageously’ applied monetary policies to avoid similar mistakes. The
Fed cut its lending rate to near zero, extended huge financial
assistance to the banking system, in particular, the largest investment
banks that were ‘too big to fail’, and then applied ‘unconventional’
monetary policies, namely expanding the quantity of money (quantitative
easing) by buying up government, corporate and mortgage bonds from the
banks to stimulate the economy. The Fed’s balance sheet has tripled
through QE purchases to 30% of US GDP.
Bernanke is convinced that this policy was a success in saving the
capitalist economy. But was it? First, it did not really avoid a
financial meltdown. Sure, the likes of Goldman Sachs, Morgan Stanley or
JP Morgan did not go bust. But Bears Stearns, AEG and Lehmans did (and
Merrill Lynch nearly did). And so did most of the leading mortgage
lenders. Moreover, hundreds of smaller banks and lenders across the US
went bust.

Second, Bernanke’s great anti-depression monetary policies have not
restored world and US economic growth and employment back to pre-crisis
levels. In his AEA speech, Bernanke claimed that: “Skeptics have
pointed out that the pace of recovery has been disappointingly slow,
with inflation-adjusted GDP growth averaging only slightly higher than a
2 percent annual rate over the past few years and inflation below the
Committee’s 2 percent longer-term target. However, as I will discuss,
the recovery has faced powerful headwinds, suggesting that economic
growth might well have been considerably weaker, or even negative,
without substantial monetary policy support.”
Maybe this counterfactual defence is right but here we are nearly two
years later and the US economy is still growing well below pre-crisis
levels and the global economy is showing increasing signs of diving back
into a new recession – see the latest IMF estimate.
Indeed, now Bernanke reckons that he is not sure the US economy could
handle four quarter-point rate hikes as proposed by some economists and
Fed officials. The Fed interest rate may have to stay near zero forever.

Bernanke posed the problem for the strategists of capital at an IMF conference in 2013: “Our
continuing challenge is to make financial crises far less likely and,
if they happen, far less costly. The task is complicated by the reality
that every financial panic has its own unique features that depend on a
particular historical context and the details of the institutional
setting.” What we need to do is to“strip away the idiosyncratic aspects of individual crises, and hope to reveal the common elements” of these ‘panics’. Then we can “identify
and isolate the common factors of crises, thereby allowing us to
prevent crises when possible and to respond effectively when not.”

Indeed! But Bernanke’s own challenge does not seem to have been met
by him. And yet there were such clues in Bernanke’s own AEA speech. He
said: “Like many other financial panics, including the most recent
one, the Panic of 1907 took place while the economy was weakening;
according to the National Bureau of Economic Research, a recession had
begun in May 1907″.

Exactly. And Bernanke could have added that the 2008 recession was
preceded by the credit crunch of 2007 and before that by a sharp fall in
the mass of profits generated from early 2006 onwards. It was the same story before the panic or crash of 1929 that led to the Great Depression. A
fall in profits and output had started a year before. So there was a
crisis in production behind the financial ‘trigger’ of ‘excessive’
speculation in copper (1907); stocks (1929); real estate (2008).
Speculation was ‘excessive’ and ultimately ‘risky’ because the value
generated to deliver gains on such investments did not materialise.

This is a much more coherent explanation of the recurrence of crises;
namely the tendency for profitability in capitalist production to
decline and eventually leading to an outright fall in profits. Then a
credit-fuelled boom turns into a speculative panic or crash.

Bernanke would like us to think that he courageously saved the world
by adopting unconventional monetary policies learnt from the lessons of
the Great Depression and in the teeth of orthodox opposition. But he
did not save the world but only the banks (the biggest ones) and his
unconventional monetary policy has not revived the US economy, let alone
the world, but only fuelled a new credit-led stock market and bond boom
for the 1%. ‘Courage’ in a crisis based on confusion won’t save the
world.